4.2 Real vs Nominal Interest Rates

Who is worse of when unexpected inflation is higher than anticipated?

Borrowers are better off and lenders are worse off.

Is there a difference between expected and unexpected inflation?

Yes, the higher unexpected inflation makes the real rate of return on a fixed rate saving and loans lower.

What is the fisher effect?

economic theory that describes the relationship between inflation and both real and nominal interest rates.

What is the nominal interest rate?

the percentage increase in money that the borrower pays (not adjusted for inflation) Nominal = real interest rate + expected inflation

What is the real interest rate?

the percentage increase in purchasing power that a borrower pays (adjusted inflation) Real = nominal interest rate - expected inflation

Who charges nominal interest rates?

they are charged by banks on loans, but are not adjusted for inflation

What are real interest rates?

they are the real rate of return on investments and loans, and they are adjusted for inflation.